The U.S. Trade Deficit: How Much Does It Matter?

Economic

Summary:

President Trump has made reducing U.S. trade deficits a priority, but economists disagree over how much they matter and what to do about them.

What is a trade deficit?

A trade deficit occurs when a nation imports more than it exports. For instance, in 2024 the United States exported nearly $3.2 trillion in goods and services to the world, while it imported $4.1 trillion, leaving an overall trade deficit of more than $900 billion. The deficit in goods, at $1.2 trillion, is higher than the total deficit, since a portion of the goods deficit is offset by the surplus in services trade. Services, such as tourism, intellectual property, and finance, make up roughly one-third of exports, while major goods exported include aircraft, refined petroleum and other fuels, and transportation equipment. Meanwhile, imports are dominated by capital goods, such as computers and telecom equipment; consumer goods, such as apparel, electronic devices, and automobiles; and crude oil.

It is important to differentiate a country's overall, or global, trade deficit from its bilateral trade deficits. The United States has both a large overall deficit in its trade with the rest of the world and substantial bilateral deficits with a number of individual countries. But it is possible for a country to have bilateral deficits with certain countries, surpluses with others, and balance in its overall trade with the world. In other words, even if the United States were to “fix” its overall trade deficit, it could—and likely would—have bilateral deficits with some countries. (One way to think about this is to consider the financial situation of individual consumers, who could spend no more overall than they earn but still have “bilateral deficits” with their grocer or barber and a “bilateral surplus” with their employer.)

What causes a country's overall trade deficit?

The fundamental cause of a country's overall trade deficit is an imbalance between its savings and investment rates. As economists explain, the reason for the deficit can be boiled down to the United States as a whole spending more money than it makes. That additional spending has to, by definition, go towards foreign goods and services. Financing that spending happens in the form of either borrowing from foreign lenders or foreign investing in U.S. assets and businesses.

Economists generally see these factors as more important than trade policy in determining the overall deficit. That's because making it easier or harder to trade with specific countries tends to simply shift the trade deficit to other trading partners. Thus, economists warn against conflating bilateral trade deficits, which reflect the particular circumstances of trading relationships with specific countries, with the overall trade deficit, which reflects underlying forces in the economy.

How has the U.S. trade deficit changed over recent decades?

Today's $918.4 billion overall U.S. trade deficit, representing about 3.1 percent of gross domestic product (GDP), is down from a 2022 peak of more than $944 billion, which at the time was around 3.7 percent of GDP. The deficit has averaged $594 billion since 2000, much higher than in previous decades, when it accounted for well below 2 percent of GDP. The United States ran either a surplus or a small deficit through the 1960s and 1970s, after which a large deficit opened in the 1980s and continued to expand through the 1990s and 2000s.

The largest U.S. bilateral trade imbalance by far is with China. The United States ran a $295 billion goods deficit with China in 2024 (partially offset by a U.S. services surplus with China of $32 billion). The next largest contributor to the goods deficit, at $235 billion, is the European Union, followed by Mexico at $172 billion, Vietnam at $123 billion, and Taiwan at $73.9 billion.

The U.S. Trade Deficit: How Much Does It Matter?_1

The trade deficit with China expanded dramatically beginning in the early 2000s from an average of $34 billion in the 1990s. Some economists refer to this as the “China Shock” and attribute it to the unexpectedly rapid growth in China's exports of manufactured goods to the United States in the late 1990s and early 2000s. This happened as Beijing undertook deep economic reforms and implemented policies to subsidize production, accelerate industrialization, and boost exports. Economists also note the acceleration of Chinese export growth after the country's entry into the World Trade Organization (WTO) in 2001.

More recently, China has experienced another export surge, leading to what CFR senior fellow Brad W. Setser calls the “Second China Shock.” This second massive wave of Chinese exports is caused in part by the large increase in global demand for goods due to the COVID-19 pandemic, decreased domestic demand in China, and China's increased competitiveness in the world market due to the government's strategic investments in high growth sectors (e.g., semiconductors, clean energy, electric vehicles).

These factors help explain China's contribution to the overall U.S. trade deficit, as well as the deficit’s concentration in the manufacturing sector. U.S. manufacturing employment dropped from 31 percent of private sector employment in 1970 to 9.7 percent in 2023, a fall that economist Kyle Handley says was accelerated by Chinese competition. However, he agrees with many economists that the bulk of the reduction of labor in the manufacturing sector can be attributed to automation, productivity increases, and demand shifts from goods to services.

Why are some policymakers concerned about trade deficits?

President Trump, who campaigned for his second term on ending trade imbalances, argues that trade deficits threaten U.S. economic and national security and blames “unfair and unbalanced” trade agreements with countries like Canada, China, and Mexico for causing the growing overall deficit.

Peter Navarro, senior counselor to the president for trade and manufacturing, believes that the overall trade deficit threatens national security, in that the United States depends on foreign debt and foreign investment to finance it. Navarro has referred to the trade deficit as “a brake and bridle on both GDP growth and real wages in the American economy while encumbering the U.S. with significant foreign debt.”

In his executive order imposing reciprocal tariffs, President Trump cited large and persistent goods deficits as evidence of the lack of reciprocity in bilateral trade relationships. Trump blamed the deficits for hollowing the U.S. manufacturing base, hindering scaling of U.S. advanced manufacturing, threatening critical supply chains, and reducing the U.S. defense-industrial base to dependence on foreign adversaries.

Trump's team calculated reciprocal tariffs in addition to the standard 10 percent for every country by taking their bilateral trade deficit in goods as a share of their total exports to the United States and dividing by two. CFR President Michael Froman, a former U.S. trade representative, explains that the Trump administration's approach to calculating reciprocal tariff rates assumes that the bilateral trade deficit is “a catch-all quantitative measure of unfair trade practices, not a reflection of comparative advantage.”

Some Democratic lawmakers, labor groups, and manufacturers also criticize trade deficits on the grounds that some foreign countries—especially China—have used unfair practices such as currency manipulation, wage suppression, and government subsidies to boost their exports, while blocking U.S. imports. Brookings researchers Joshua P. Meltzer and Margaret M. Pearson identify China's overcapacity as “linked to China's increasingly mercantilist approach to trade” and suggest the United States should “rebuild a global rules-based trading system” to address China's practices, while also acknowledging the importance of a continued U.S.-China trade relationship.

The deficit's concentration in the manufacturing sector has heightened concerns among some economists over job losses and their repercussions in local communities. Research by the Economic Policy Institute suggests that the surge in Chinese imports lowered wages for non-college-educated workers and cost the United States 3.7 million jobs from 2001–2018. One study from Stanford University found that the China Shock accounted for 59.3 percent of all U.S. manufacturing job losses over a similar period (2001–2019).

Some economists worry about the consequences of large and persistent imbalances. In 2017, the Peterson Institute's Joseph Gagnon warned that the debt necessary to finance the overall trade deficit was heading toward unsustainable levels. Former Federal Reserve chair Ben Bernanke and Jared Bernstein, chair of the Council of Economic Advisors under President Biden, have argued that the large inflows of foreign capital that accompany trade deficits can lead to financial bubbles and could have contributed to the U.S. housing crash that began in 2006. Jeff Ferry from the Coalition for a Prosperous America notes that a growing trade deficit has been associated with a weak economy, as in the early 2000s, which he says is evidence of the potential for a large trade deficit to drain demand from the domestic economy and slow growth when the economy is performing under its potential.

Some economists worry about the consequences of large and persistent imbalances. The Peterson Institute's Gagnon warns that the debt necessary to finance the deficit is heading toward unsustainable levels. Former Federal Reserve chairman Ben Bernanke and Jared Bernstein, an economic advisor to Presidents Bill Clinton and Barack Obama, have argued that the large inflows of foreign capital that accompany trade deficits can lead to financial bubbles and may have contributed to the U.S. housing crash that began in 2006. Others note that a growing deficit has been associated with a weak economy, as in the early 2000s, which they say is evidence of the potential for a large deficit to drain demand from the domestic economy and slow growth when the economy is performing under its potential.

What are the arguments against focusing on the deficit?

Many economists say the overall trade deficit is not itself a problem for the U.S. economy. That's because a larger trade deficit can be the result of a stronger economy, as consumers spend and import more while higher interest rates make foreign investors more eager to place their money in the United States.

CFR Fellow Inu Manak challenges the Trump administration's assertion that “trade deficits mean you lose, and surpluses mean you win.” She says that Trump's narrow focus on trade in goods, which disregards the services surplus, is particularly unhelpful.

“It is false to suggest that the trade deficit is somehow reflective of trade barriers, and the administration's cherry-picking of the data (which excludes services where the United States has a surplus) further points to the arbitrary nature of its claims,” Manak wrote, while questioning the legal basis of Trump's tariff policies.

Some economists argue that the singular role of the U.S. economy in providing liquidity to the global economy and driving demand around the world makes a U.S. trade deficit important to global economic stability. The dollar's role as the global reserve currency and primary tool for global transactions means that many other countries rely on holding dollar reserves, creating massive demand for U.S. financial assets. This means that the United States pays little for its foreign borrowing, allowing it to finance its high consumption at low cost, which boosts global demand.

Other economists warn that increasing trade restrictions in the interest of moving toward U.S. trade surpluses could lead to lower global growth, inflation, and more economic instability among U.S. trade partners. CFR's Benn Steil and Elisabeth Harding also flag the potential reduction in real GDP growth due to protectionist trade policies.

Many economists worry that too much focus on trade deficits could lead to a revival of protectionism and a new global trade war that would make everyone worse off, especially in an era of supply chains that cross many borders. Maurice Obstfeld, senior fellow at the Peterson Institute, pushes back against the idea that job losses in manufacturing are connected to the trade deficit and further challenges the argument that tariffs will improve the trade balance or create manufacturing jobs.

Stephen J. Rose of the Center for Strategic and International Studies says government promises that restrictions on imports from China or elsewhere will revive manufacturing ignore the fact that technological progress plays a much larger role in deindustrialization than does trade. In fact, the U.S. economy began shifting away from manufacturing long before the proliferation of trade agreements in the 1990s, Rose explained.

Instead, the Peterson Institute's Mary Lovely says it is better to recognize that trade deficits are neither all good or all bad but rather involve trade-offs: the U.S. economy benefits from foreign goods and investment even as a high deficit displaces some workers and adds to the national debt.

What policy options have been proposed to reduce trade deficits?

Imposing high tariffs. President Trump has repeatedly promised to reduce trade deficits by imposing high tariffs on foreign trading partners, a key pillar of his economic platform. Commerce Secretary Howard Lutnick says using broad-based tariffs will help create “reciprocity, fairness, and respect.” Some economists say negotiating better access to the Chinese market for U.S. exporters could help reduce the bilateral deficit but warn that additional tariffs will make China less likely to grant extended access to U.S. firms.

In contrast to the Trump administration's approach, Gagnon says that data show “tariffs have little direct impact on deficits.” He says higher tariffs lead to both reduced imports and exports, as well as less total income, noting that tariffs “ultimately lead to less business innovation, slower productivity growth, and lower household living standards.”

Reducing the fiscal deficit. As an alternative to tariffs, Gagnon argues for using fiscal and exchange rate policy to reduce the trade deficit. He emphasizes “reducing the fiscal deficit and pushing down the overvalued dollar,” arguing that a weaker dollar would likely boost U.S. exports.

Boosting U.S. exports. CFR Senior Vice President and Director of Studies Shannon O'Neil emphasizes the importance of boosting U.S. exports to reduce deficits, return higher-paying jobs, and increase innovation. She argues that pulling back from trade agreements and using sweeping tariffs on imports undercut the potential for U.S. exporters to succeed because they are excluded from access to cheaper inputs. Instead of focusing on reducing imports through protectionist policies, a more effective strategy could be to increase U.S. exports.

Amending U.S. tax law. Alexander Raskolnikov, Wilbur H. Friedman professor of tax law at Columbia Law School, and CFR's Steil write that one way to address the deficit with China is by amending American tax law.

Current U.S. tax law treats foreign investors in the United States, including Chinese investors, more favorably than domestic investors. The resulting influx of foreign capital contributes to the trade deficit. Raskolnikov and Steil write: “If the U.S. tax subsidy for the import of foreign capital were eliminated, Chinese investors would have less motivation to outbid Americans for U.S. assets and, by extension, less incentive to dump goods in this country in return for dollars.”

Though it would not be a silver bullet, amending U.S. tax law and eliminating subsidies for foreign portfolio investment could moderately reduce the deficit without the downsides associated with tariffs and other protectionist measures.

CFR's Setser argues that the United States should reform its corporate tax code to limit offshoring and disincentivize profit shifting, especially in the pharmaceutical industry. Internationally, the United States and its allies should create subsidy sharing agreements in key sectors (e.g. electric vehicles and steel), expanding the market share for both U.S. and allies' firms while lowering costs.

Pressing for reforms in surplus countries. Economic reforms in surplus nations could also help. Gagnon and C. Fred Bergsten from the Peterson Institute argue that the United States should pressure countries that use foreign reserve purchases to manipulate their exchange rates by having the U.S. government counter-purchase the foreign currencies of manipulating nations. CFR's Setser says that policymakers should pressure China and other Asian countries to enact policies to raise their domestic consumption.

Cutting U.S. domestic spending and boosting the savings rate. In the domestic policy arena, boosting the U.S. savings rate could also bring down the trade deficit. As the International Monetary Fund and others have pointed out, one of the most direct ways to do that is to reduce the government budget deficit. Early in his second term, Trump established the Department of Government Efficiency (DOGE) ostensibly to reduce federal spending and lower the budget deficit. While there is widespread agreement that efficiencies could be found in spending on government operations, the reality that most federal spending goes to defense, entitlements, and interest on the debt make many question whether efforts like DOGE will make much of a dent in the overall budget deficit.

Source: CFR

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